Aecon is getting a tailwind from the energy transition to renewables and a nuclear renaissance.Fred Lum/the Globe and Mail
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Smaller-cap stocks have been snubbed in recent years as their larger peers – particularly the so-called “Magnificent Seven” technology giants – have garnered the most attention.
But many smaller companies are enticing now as they’re trading at very attractive valuations and tend to have higher growth rates than their large counterparts.
Small to mid-cap stocks are also compelling given that central banks are hinting that interest rate cuts are on the horizon. These firms often rely on outside financing, so their debt costs will fall.
Globe Advisor asked three fund managers for their top picks among undervalued, smaller-cap stocks.
Aman Budhwar, portfolio manager, Penderfund Capital Management Ltd. in Toronto
His fund: Pender Small/Mid Cap Dividend Fund
The pick: Aecon Group Inc. ARE-T
The construction and infrastructure development company is getting a tailwind from the energy transition to renewables and a nuclear renaissance, Mr. Budhwar says.
Toronto-based Aecon has contracts to refurbish Ontario’s Bruce Power and Darlington nuclear reactors and expects a similar one for the Pickering facility, which just received Ontario government approval.
Aecon expects its higher-margin nuclear business to grow to 20 per cent of construction revenue in a few years from 15 per cent once a contract to build small nuclear reactors gets booked into revenue, he adds.
Jean-Louis Servranckx, who became chief executive officer in 2018, oversaw the sale of Aecon’s roadbuilding business and brought in Oaktree Capital Management as a minority stakeholder in the utilities business to help accelerate growth. These changes are not reflected in the market’s perception of the business, Mr. Budhwar notes.
Aecon shares suffered in the past due to losses from four legacy, fixed-price lump-sum contracts. His share-price target is $32 by 2026.
The pick: Trisura Group Ltd. TSU-T
Trisura is a compelling play because the company focuses on the higher-return, specialty insurance niche versus the property and casualty business, and is expanding into the U.S. market, Mr. Budhwar says.
The Toronto-based insurer, which was spun out of Brookfield Asset Management Inc. in 2017, has a 17-year history in Canada.
Its domestic business had a high return on equity of about 30 per cent in 2021 and 2022 and was in the 26 to 30 per cent range for the first three quarters of last year, he adds.
Trisura’s U.S. business has been “growing very fast” since 2018, he says. Last year, it bought a U.S. surety business that’s waiting for regulatory approval, and will become another growth avenue, Mr. Budhwar says. So far, it has focused on fronting insurance there. (Fronting is underwriting a policy and ceding most of the risk to reinsurance partners for a fee.)
Its stock took a hit last year because of losses related to a reinsurance contract, but Trisura has since hired a chief risk officer for its U.S. business, he adds. His target price is $55 a share by the end of 2025.
Greg Dean, chief executive officer and lead investor, Langdon Equity Partners Ltd. in Toronto
His funds: Langdon Canadian Smaller Companies Portfolio and Langdon Global Smaller Companies Portfolio
The pick: The Westaim Corp. WED-X
Westaim is a private equity firm with two financial-service industry investments that are “underappreciated,” Mr. Dean says.
The Toronto-based firm was spun out of Sherritt International Corp. Westaim’s current strategy, which began in 2009 under two former managers at investment firm Goodwood Inc., is to buy, improve and sell firms that they invest in, he says.
Westaim has no debt; the firm first invested in Jevco Insurance Co., which was sold to Intact Financial Corp. in 2012. Westaim has a 17.5-per-cent stake in Skyward Specialty Insurance Group Inc. SKWD-Q, which went public in January 2023 at US$15 a share, and now trades at more than US$30 a share.
It also owns 51-per-cent of private credit manager Arena Investors LP, which has $4-billion in assets, and 100 per cent of Arena FINCOs, which includes specialty finance companies.
Westaim, which last closed at $3.59 a share, is worth $6 using a sum-of-the-parts valuation, Mr. Dean says. “It trades below cash and marketable securities so there is little to no downside.”
The pick: Esquire Financial Holdings Inc. ESQ-Q
Esquire, which provides banking services to the legal industry, is an attractive play because it has a record of creating shareholder value, has a high return on equity and almost no competition, Mr. Dean says.
Its shares trade cheaply at about 10 times forward earnings because “it’s still below the radar,” he notes.
The Jericho, N.Y.-based company owns Esquire Bank, which serves the New York metropolitan area. It targets law firms because most are structured as a partnership and retain little capital as the profits are paid out to their partners annually, he says. “They tend to need capital frequently because they don’t retain capital.”
Esquire’s stock fell sharply last April amid uncertainty after the collapse of Silicon Valley Bank, but bounced back to trade at all-time highs recently, Mr. Dean says.
A risk is more U.S. law firms being allowed to source outside capital given that some states are starting to allow that to happen, he says. Esquire has exposure to commercial real estate, but it is a small part of its loan book.
Sajan Bedi, vice president and portfolio manager, Canoe Financial LP in Toronto
His fund: Canoe Canadian Small Mid Cap Portfolio Class
The pick: Savaria Corp. SIS-T
Savaria, a maker of accessibility equipment for seniors, is getting a tailwind from an aging population globally, Mr. Bedi says.
The Laval, Que.-based company’s products range from home and elevator lifts to wheelchair lifts.
It’s also benefiting from synergies from its 2021 purchase of Sweden-based stairlift giant Handicare Group and expects “to achieve margin expansion toward 20 per cent over time versus 15 to 16 per cent today,” he adds. There is also cross-selling potential because Handicare focuses on stairlifts while Savaria is known for home elevators.
Savaria’s stock which trades at about $16, is still down from $22 a share in 2021, partly due to supply-chain issues that weighed on margins, he notes.
But Savaria, which has a 3.2-per-cent dividend yield, is expected to grow earnings in the mid-teens over the next few years, he says.
Its stock trades attractively at about 9.5 times earnings before interest, taxes, depreciation, and amortization (EBITDA) versus a long-term average closer to 11.5 times, he notes. A risk is whether it can integrate Handicare successfully.
The pick: Richelieu Hardware Ltd. RCH-T
Shares of this distributor of specialty hardware products are attractive because it’s an industry leader and growing by acquisition, mostly in the U.S. market, Mr. Bedi says.
Montreal-based Richelieu Hardware gets 80 per cent of sales from makers of housing-related products, such as cabinet or closet makers. Canada represents about 60 per cent of sales while the rest is from the U.S. he says.
The company has been able to “steal market share from smaller regional competitors,” he adds. With organic growth and acquisitions, it should “be able to compound free cash flow per share in the low-to-mid teens over time.”
Richelieu Hardware’s shares tumbled to around $42 last month from $47 earlier in January after the firm reported earnings and indicated more margin pressure than expected, Mr. Bedi says. The stock trades at about 11 times EBITDA versus a 10-year average of about 12.5 times. “That is [also] pretty attractive given its really strong balance sheet and high-quality management team.”
The biggest risk is any “meaningful softening in the housing market,” he adds.
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